EnPro Industries, Inc. (NPO) Q3 2016 Earnings Report, Transcript and Summary

Good morning. My name is Shawn, and I will be your conference operator today. At this time, I would like to welcome everyone to the EnPro Industries Third Quarter 2016 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Chris O'Neal, Vice President of Strategy, Corporate Development and Investor Relations. Please go ahead, sir.

Thank you, Shawn. Good morning and welcome to EnPro Industries' quarterly earnings conference call. I'll remind you that our call is also being webcast at enproindustries.com, where you can find the slides that accompany the call. Steve Macadam, our President and CEO; and Milt Childress, our Senior Vice President and CFO; will begin their review of our third quarter performance and our outlook in a moment. Also joining us on the call today is Ken Walker, who is our Senior Vice President and COO. But before we begin our discussion, I will point out that you may hear statements during the course of this call that express a belief, expectation or intention, as well as those that are not historical fact. These statements are forward-looking and involve a number of risks and uncertainties that may cause actual events and results to differ materially from such forward-looking statements. These risks and uncertainties are referenced in the Safe Harbor statement included in our press release and are described in more detail along with other risks and uncertainties in our filings with the SEC, including the Form 10-K for the year ended December 31, 2015 and our Form 10-Q for the quarter ended March 31, 2016. We do not undertake to update any forward-looking statements made on this conference call to reflect any change in management's expectations or any change in assumptions or circumstances on which such statements are based. Our earnings release and conference call presentation materials contain additional disclosures regarding non-GAAP financial information, collective references to EnPro and our subsidiaries, the deconsolidation of Garlock Sealing Technologies or GST, and pro forma illustrative financial information presented as if GST were reconsolidated for financial reporting purposes. These disclosures are important to understanding comments we will make on today's call and we urge you to read them carefully. Just as we did in the last two quarters, we are providing pro forma segment sales and pro forma segment profit information in conjunction with the ACRP settlement agreement announced on March 17 to provide investors with additional pro forma information illustrating each segment's results as if GST had been reconsolidated with EnPro based on confirmation and consummation of the joint plan of reorganization as described in our earnings release. Given where we are in the bankruptcy process and due to request from investors for this type of information, we believe this disclosure of pro forma operating results is instructive to investors as it reflects performance of all of our subsidiaries. Until the ACRP process is completed, however, our published GAAP financials in Forms 10-Q and 10-K will continue to reflect GST on a deconsolidated basis. Also throughout this call, we will be using the terms normalized sales and normalized segment profit. Normalized sales refers to consolidated or pro forma sales adjusted for year-over-year differences in foreign exchange translations and the impact of acquisitions and divestitures. Normalized segment profit refers to consolidated or pro forma segment profit adjusted for foreign exchange translation, the impact of acquisitions and divestitures, acquisition-related expenses, restructuring charges and the impact of reflecting the total projected loss and the multi-year EDF contract and proportionate to the percentage of completion of the contract as if the accounting practice for the positive gross margin long-term contracts. The intent of providing normalized results is to provide greater clarity of results in the current period compared to the prior period. And now, I'll turn the call over to Steve.

Thanks, Chris and good morning, everyone. As an opening comment, I'd like to share that I'm pleased with our team's effort to deliver the best possible performance in market conditions that continue to be quite challenging. Our total pro forma segment profit for the quarter decreased by 2.5%, by 4.4% decline in pro forma sales. This resulted in a slight improvement in pro forma segment margin to 11.9% in the third quarter this year from 11.7% last year. The margin improvement was driven by a combination of our cost reduction efforts, significant restructuring and strong production efficiency improvements. This hard work is keeping our margins stable in an extremely difficult demand environment, and greatly improving our competitive position for the future. Total pro forma adjusted EBITDA decreased by 2.6% versus a year ago. Throughout the current industrial, we've taken a systematic and balanced approach to managing our performance. Over the past several years we've invested a lot of time, effort and capital in developing and improving foundational capabilities that we believe are critical to our long-term productivity, innovation, and growth. While the current market conditions require that we reduce cost and exit underperforming parts of the business. We implemented mitigating actions with a clear focus on the undermining our future success. These actions have significantly improved the profitability of our engineering products segment, and partially offset partly offset the negative effects of market headwinds on our overall results. Just as most of our industrial peers have announced in recent weeks, the markets conditions in the third quarter have continued to be weak. Nearly all of the markets that we serve have seen negative year-over-year trends and our sales have closely tracked that activity. Commodity prices in general remain depressed which is having a ripple effect through the oil and gas, metals and mining, and refining markets. In addition to those market sales have remained depressed in gas turbine equipment and general industrial. Heavy duty trucking is also showing some weakness. Our nuclear and aerospace volumes were down due to the timing of some large orders. Automotive demand remains relatively flat. Our sales in semiconductor and food and pharma were quite strong in the third quarter, our semiconductor business unit recorded its highest quarterly sales since we acquired Tera Technologies in 2011. And the Rubber Fab acquisition in the food and pharma space has been exceeding expectations while still early. The column on the far right, Slide 5 provides directional guidance on how we currently see our end markets performing in the fourth quarter. I will discuss how these market trends are likely to affect our outlook later in the call. Before Milt provides detail on our financial results. I want to provide updates on ACRP progress; another major new engine program in power systems, the status of our cost reduction efforts and strong early performance of the Rubber Fab acquisition. The ACRP remains on-schedule, since March 17 of this year when we announced the comprehensive settlement; we've been working on the legal and administrative steps necessary for approval of the plan to reorganization. On July 29, the bankruptcy judge issued an order approving the disclosure statement solicitation and confirmation procedures and schedule for confirmation. The order established several key dates including a deadline of December 9 for voting, a deadline of December 30 for completion of the tabulation and certification of the voting results; and a date of May 15, 2017 for confirmation hearings to begin. The solicitation period began on August 22 and a national program to provide notice to unknown clients is ongoing. We are negotiating but have not yet finalized the definitive agreement with the workers compensation boards for each of the ten Canadian provinces which we expect to be consistent with the present value estimate of approximately $17 million that was previously announced in connection with the global settlement agreement. As we discussed last quarter, absent appeals we would expect the bankruptcy court and the district court to enter final orders confirming the plan and issuing a plan injunctions within 60 days of commencement of the confirmation hearing leading to a reconsolidation under this timeline in the third quarter of next year. I'm very pleased to announce that Fairbacks Morse drew it's part of eastern shipbuilding was recently selected for the U.S. Coast Guard's new offshore patrol car or OPC which will provide a critical capability bridge in the coast guards fleet. The OPC will serve between the National Security Cutter which patrols the open ocean; and the Fast Response Cutter which serves closer to shore. Each OPC vessel will be powered by two Fairbanks Morse diesel engines. The initial procurement program will include nine vessels and we expect to begin recognizing revenue on the program in 2017. Ultimately, the Coast Guard is expected to order 25 ships which is expected to make it the largest vessel procurement program in the Coast Guard's history. The first ship is scheduled to enter service in 2021. I'm particularly excited about this development because the OPC program is our first new engine program with the U.S. Coast Guard in many years. We have had an excellent long-standing relationship with the Coast Guard but over the past couple of decades we have focused on aftermarket parts and service for our installed engines. Only recently have we renewed our efforts to win new engines program and the OPC is the first major milestone that show success from our team's hard work and dedication to this important customer. The OPC win with the U.S. Coast Guard add to a robust list of U.S. Navy programs for which Fairbanks Morse has been selected in recent years. These include but are not limited to the LCS, the CVN, the LPD, the MLT and the TAO programs. You will recall we spoke about the TAO program in our last quarterly call. The OPC program is in addition to these navy program. So in total, assuming that Fairbanks is selected for all the future ships in each program which is generally the practice; the U.S. Navy and the Coast Guard order all the vessels planned for program and the government funding appropriations are approved for all plant ships. The current expected future potential engine revenue for Fairbanks Morse is nearly $1 billion over the next 18 years. Of course, aftermarket parts and service on each of these programs will be incremental to this and extend over the full 30 to 40 year life of these engines. In our second quarter earnings call we announced that as a result of continued soft conditions across many of our served markets; we were moving forward to further reduce costs across all segments and the corporate office. Since Q2, our plan has been to reduce pro forma operating costs by approximately $20 million on an annualized pro forma basis relative to the run rate of the first half of this year. It's important to note that we will achieve this reduction without weakening the capabilities that we've developed over the past few years to support long-term value creation. Implementation is proceeding on plan, we've completed the majority of actions required to achieve our cost savings goal, outstanding actions that remain are primarily in our European locations where the restructuring process requires more time. We expect to complete all actions by the end of the year as originally planned. Excluding restructuring cost, SG&A cost they were added with Rubber Fab and net of a positive impact related to usual items that affected SG&A, our pro forma corporate and segment operating expenses were $5.2 million lower in the third quarter than they were during the same period last year. On the same basis, our corporate and segment operating costs were $5 million lower than the third quarter than they were in the second quarter this year. The majority of these reductions have come from personnel related costs and purchased services, plus benefits from the exit of underperforming sites in sealing products and engineer products completely over the last twelve months. Finally, in April, we completed the Rubber Fab acquisition to support Garlock growth in the hygienic products market. You may recall that Rubber Fab is a leading supplier of critical process consumable for the pharmaceutical bioprocessing and food and pharma sectors. The acquisition has added a number of innovative and differentiated products to Garlock's hygienic products portfolio and provide an enhanced distribution and customer access. We continue to be very pleased with the performance of this business as customer feedback has been favorable and the financial results have continued to exceed our expectations. Our current forecast for 2016 is that Rubber Fab sale will exceed our justification case by approximately 8% and EBITDA as a percentage of sales will be even more favorable. Rubber Fab's distribution channel to the hygienic market is providing access to new customers for Garlock's Biopro product line, and is starting to contribute to that product line success. Garlock is also leveraging its corporate level relationships with national distributors to open new local distribution or Rubber Fab's products; and planning is underway to expand distribution of Rubber Fabs products in Asia. The integration of our systems in process at Rubber Fab is also proceeding according to plan. Warehouse at the buildup processes which are important for coordinating orders and shipments of Garlock's and Rubber Fab's products through each company's existing distribution have been integrated and are performing well. Equally important, employee engagement has been excellent. We are continuing to look at growth in the hygienic market. Now I will turn the call over to Milt.

Thank you, Steve. As discussed before the pro forma segment results that we’ll discuss are prepared as a TST, had been reconsolidated on the basis described in our earnings release. As a reminder, most of the difference between consolidated and pro forma segment information is in sealing products. With only small differences in engineered products and power systems, stemming from foreign operations of those segments included NGST formed subsidiaries. It is important to note that the pro forma results do not represent a projection of financials as of the future date of expected reconsolidation. Our pro forma third quarter sales of $331.1 million were down 4.4% from the same period 2015. Net of small CPI divestiture in Thailand, acquisitions contributed $4.1 million and foreign currency translations reduced sales by $1.7 million. Excluding the impact of these factors pro forma sales for these quarters were 5.2% lower compared to a year ago. The organic sales decline was driven primarily by continued weak demand that we are facing across many of our end markets. I will provide more color by market in a moment while reviewing quarterly results for each segment. Pro forma gross profit for the quarter of $116.2 million was 4.2% lower than in the third quarter of 2015 and pro forma gross profit margins were up 10 basis points year-over-year to 35.1% despite the lower sales. Total pro forma SG&A declined in the third quarter 2016 by $4.5 million to $82.3 million. As a percentage of pro forma sales, pro forma SG&A decreased in the third quarter to 24.9% from 25.1% in the third quarter of last year despite the year-over-year decline in sales. As Steve noted previously, excluding the restructuring cost, acquired SG&A cost associated with the rubber Fab acquisition and several unusual items in the quarter including the reversal of a burnout accrual, pro forma SG&A was $5.2 million lower than in the prior year and $5 million lower than in the second quarter. The decrease was driven by focused cost reductions and side exits. Corporate expenses were $6.4 million in the third quarter and $6.3 million in the same period last year. Excluding restructuring cost of $300,000 in the current quarter, corporate expenses were $6.1 million. Year-over-year decrease was driven primarily by lower employee cost and purchase services offset by new corporate funded R&D programs. As Steve discussed earlier in the third quarter we completed the majority of the remaining actions related to the previously announced companywide reduction initiatives. Upstanding actions are now primarily European locations where Labor Laws dictate a longer timeline. And we expect most of the remaining access to be completed by the end of the year. We are confident that we are on track to reduce pro forma operating costs by approximately $20 million on an annualized performance basis relative to the run-rate of first half of this year. Related all re-structuring actions we encourage $2.2 million of pro forma restructuring costs in the third quarter and currently expect to incur approximately $2.4 million in the fourth quarter for total pro forma restructuring cost of around $12 million in 2016. Pro forma adjusted debt income which adjusts pro forma net income for items such as restructuring, legacy environmental reserves and normalized tax accruals, all are shown in the reconciliation table in our earnings release are $18.4 million down $1.1 million from the year ago. Most of the year decrease was attributable to weaker demand across many of our businesses, partially offset by cost improvements from restructuring and other cost reduction initiatives, supply chain savings and production efficiencies. Pro forma sales in the ceiling product segment were $213.1 million down $5.6 million over the third quarter of 2015. Excluding the impact of the Rubber Fab acquisition which contributed $4.6 million to pro forma sales and foreign exchange which reduced pro forma sales by approximately $1.1 million pro forma sales were down 7.2% in the third quarter, weak demand and refining steel, mining, nuclear, gas turbine equipment, heavy duty trucking and general industrial drove much of the decline. Sales in the quarter also affected by the decision to exit from approximately $1 billion of unprofitable LE business, and sprinkles air springs unit, it was acquired in July of last year, the third quarter sales decline was partially offset by strength in our semiconductor in the pharma businesses. Recent strong orders in semiconductor, food and pharma and nuclear are anticipate to be positive drivers of fourth quarter results and into 2017, these markets combined represent approximately 9% of EnPro sales. Performance segment profit of $28.8 million was down 2% from the third quarter of last year performance segment margins increased to 30.5% from 30.0% during the same period a year ago, excluding the impact of restructuring the contribution from the river that acquisition foreign exchange at a $1.5 million positive contingent purchase price for farcical acquisition. Third quarter segment margins declined to 30% from 30.7% in the same period last year, this normalize margin decline was driven by reduced volume related to market headwinds, and approximately $500.000 of costs related to the air springs acquisition, all that partially offset by supply chain savings and cost reductions. Pro forma segment SG&A cost, were $47.5 million of third quarter, compared to $50.1 million in the prior year and $51 million in the second quarter, excluding SG&A costs associated with the river that acquisition, restructuring cost and unusual items, segment SG&A cost were $3 million lower in the third quarter versus last year and $1.8 million lower than in the second quarter of this year. The reductions were given back combination of restructuring, focused cost reductions, and other changes. In the engineer product segment third quarter sales, pro forma sales of $65.8 million declined by 9.1% from the third quarter of 2015, a year-over-year sales decline is the result of planned side exit, completed during the past 12 months. Weakness in the flu power and industrial markets softening of European compressor parts and services, and continued weakness in the North American oil and gas market. Automotive sales for the quarter were relatively flat year-over-year, excluding the impact of foreign exchange sales declined 7.6% year-over-year. pro forma segment profit of $3 million was up from $1.9 million in the third quarter of last year, due to improved labor efficiency, lower manufacturing overhead, headcount reductions and other savings related to restructuring activities, pro forma segment margins were 4.6% in the third quarter versus 2.6% in the prior year. Excluding restructuring costs and the effective foreign exchange pro forma segment profit was $4.5 million for the quarter from $2.4 million a year ago, and pro forma segment margins were 6.8% up from 3.3% in the prior year. Pro forma segment SG&A cost were $21.8 million in the third quarter compared to $22.8 million in the prior year and $20.4 million in the second quarter, excluding restructuring costs, segment SG&A cost were $1.6 million lower in the third quarter versus last year at $3.2 million lower than in the second quarter this year. The reductions were given by combination of side exits restructuring and focused cost reductions. In the power systems segment pro forma sales were $53 million up 7.7% compared to the third quarter of 2015, the sales increase was largely due to an increase in new engine revenue, offset by lower aftermarket revenue compared to the prior year. Pro forma segment profit for the quarter was $7.6 million down 80.3% from a year ago, primarily as a result of a weaker mix of engine sales versus aftermarket parts sales, and breakeven margins on the ETF engine revenue, partially offset a lower SG&A cost. Excluding restructuring costs and reflecting the total projected loss of a long term ETF contract, and proportion to the percentage of completion of the contract, as is the accounting practice for positive gross margin long term contract, pro forma segment profit was down 25.3% in the third quarter of 2015. Pro forma segment SG&A cost were $7.4 million in the third quarter compared to $8 million in both the prior year and the second quarter of this year, excluding restructuring costs, segment SG&A costs were down $500.000 in the third quarter versus last year, and flat appeared in the second quarter of this year. The year-over-year reduction was driven by focus cost reductions. As a reminder GAAP rules require that we evaluate the impact of the dollar to euro foreign exchange rate, on the ETF contract each quarter since we are in a lost position, the relative stability of the exchange rate from the end of the second quarter to the end of the third quarter resulted in no significant impact our results. As we discussed last quarter, we remain committed to our strategy of creating shareholder value to earnings credit and balance capital allocation, including discipline investments for organic growth and innovation, strategic build on acquisitions, and returning capital to shareholders to dividends and share repurchases. In the third quarter, we repurchased approximately $160.000 shares for $8.1 million, as part of the ongoing 50 million share repurchase program authorized by our board of directors in the fourth quarter of last year. Through the end of the third quarter 2016, we have spent $31.7 million of the $50 million authorization; additionally we paid a 21 per share dividend in September and yesterday announced $0.21 per share dividend payable in December. Last quarter we outlined our pro forma net debt and leverage ratio, taking into account blending into the ACRP consensual agreement, as an update and as shown on Slide 15 had reconsolidation, and an initial press funding occurred at the end of the third quarter our pro forma leverage ratio would have been approximately 2.5 times in contrast to the 4.9 times leverage ratio indicated by our consolidated results, as point out last quarter this pro forma leverage calculation does not include tax that of the planned funding that will be realized over time, last quarter we also provided a summary of our pro forma valuation relative to industrial peers, as an update our pro forma adjusted enterprise value EBITDA multiple at the end of the third quarter was approximately 7.7 times compared to a multiple of 11.6 times indicated by our consolidated results, then I'll turn the call back to Steve.

Thanks Milt, will close to the discussion of current market conditions and our outlook for the remainder of the year, and then we'll take questions as we've described in the past, most of our businesses have relatively short order to shift the cycle which naturally limits our visibility of future demand with the exception of new engine production in power systems, typical order backlog ranks as well as 5-10 business days to a couple with 50% or more of our orders being fulfilled in a month or less, this characteristic coupled with the current have certainty of the global markets makes forecasting sales even more two quarters into future, as we've said we're experiencing weakness in heavy duty trucking or gas refining metals and mining industrial gas service in general industries, demand in automotive in aerospace is holding steady and semiconductor including one of our performing well, we have also built a robot backlog of nuclear orders, a portion of which is expected to ship in the fourth quarter. We expect pro forma sales to be flat to down a single low, single digit percentage on a currency neutral basis with growth attributable to the acquisitions completed, as early to that 2015 offset by general market related weeks, we indicated last quarter that we expected pro forma adjusted EBITDA to be flat to a low single digit percent decline compared to the 2015, excluding the costs associated with the AVL power train engineering offsets, and any changes related to ETF that are largely a function of foreign currency rates. We still believe we will be in that range but more likely towards the lower end both pro forma sales and pro forma adjusted and pro forma adjusted EBITDA assume constant currency from the end of the third quarter through the end of the year. I want to emphasize market development performance because our results either positively or negatively relative to this guidance. And now I’ll open the line for your questions.

[Operator Instructions] And your first question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is now open.

Good morning. So I just wanted to a little bit more to do it because of the three businesses written Sealion [ph] it looks like core growth - growth was negative 20. If I look at the right for the ST. business but maybe just work through maybe how technics did, how stem code did, and how…

Jeff as Steve and I discussed it was pretty challenging from a market condition standpoint in the segment. The same factors we discussed for the earlier in the year for the first two quarters of the year and continued the third quarter. With that ceiling and this is above the consolidated and deconsolidated part Garlock. I think the we saw some notice of deterioration that we saw in the Q3 expected, it wasn't unexpected it was the effects of a slowdown on the shipping side things which affected STEMCO in a fairly significant way on the quarter-over-quarter basis. We were down year-over-year on the top line in the segment. It was most noticeable that STEMCO is the largest decline, and take Maddox had a mid-single digit decline year-over-year on a normalized basis and Garlock was in that same category or same neighborhood if you take out the impact of the Rubber Fab acquisition. And given the markets that your question about GST, I don't have the specific numbers for GST in front of me. We could pull it out but given the fact that we have much more exposure to metals and mining refinery some of the challenge markets. We did experience a more significant decline year-over-year in GST than we did in the consolidated part of Garlock. Our pipeline business remained which is a consolidated positive on year-over-year as was the case in the second quarter. Does that answer your question, Jeff?

Steve, you mentioned having a little bit better visibility; can you just talk about how you're thinking about that trajectory into 4Q and into 2017? I'll then get back in queue, thanks.

Well, I think - I think we're better stay on the current pace in Q4 that we've been on. I mean we're that we're scheduled to ship a bunch Engines starting next year for ETF, we'll get a couple out in Q4, but that percent complete basis anyway, so I think if you look at our aftermarket projection relative to Q3 will be - will be a little bit lighter than that and anything course we ship from any work we do on ETF whether it ships or not [indiscernible].

Jeff you may remember we had a really strong fourth quarter from an aftermarket parts standpoint last year in 2015, and the and we don't we don't see that pattern happening this year. So we're expecting power systems to be down on your basis we can head to the next quarter.

Your next question comes from the line of Ian Zaffino with Oppenheimer. Your line is now open.

Hi. Great. Thanks, guys for taking the call. Question would be on the acquisition side or on the acquisition front. What are you seeing as far as the pipeline right now and just given all the weakness, are you seeing any potential targets that are in a weakened position where you might be able to take advantage of that or are they also kind of holding out maybe for some type of cyclical recovery Thanks.

Yes. We're seeing a fair amount of activity but, it's mostly from companies that have been healthy and that are operating quite well. We're being very selective because prices of those businesses that are performing well remain elevated, but we do have a backlog that we'll continue to work through it. We have not seen a pickup in I would say distressed assets. I think most companies that have had healthy balance sheets are choosing to wait until some recovery before making a decision of coming to market. I know in the only gas industry we've seen some of that, but given where our focus has been sealing products with Technetics Group, with aerospace, with industrial gas turbine businesses, semiconductor and the hygienic space in Garlock where we've had a great deal of focus. We're not seeing distressed assets coming to the market right now.

And that has been our focus, Ian. I just want to add to that. We're not looking at this point to dabble down in oil and gas, metals and mining and so forth. We're trying to pick off companies that strengthen our position in some markets where we'd have a little bit better long-term outlook price, like Milt said like aerospace and even in trucking where we have seen some weakness, but our focus as you know is very much on the aftermarket and even though we've seen some sequential weakness in the aftermarket, it's not that falling off the cliff by any stretch. New truck new trailer builds are down quite a bit while still at decent levels at least on the trailer relative to history. So we still believe that we have a very strong position through STEMCO in the trucking aftermarket, so that might be a place - we're not looking any assets now that we think are distressed. The best where we believe we can still get a reasonable valuation but we're looking in food and pharma, in semiconductor and others that have a little bit better long term prospects and not focusing on some of the deep traditional parts of the Garlock and Technetics. That's our strategic direction. That's premeditate, in other words, that's what we're thriving because we're not just about to doing acquisition for acquisition's sake, we're trying to do it to strengthen the company for the future in terms of our portfolio, of lives we serve.

All right, thank you very much. That's really helpful answer. Thanks for the color.

Yes.

[Operator Instructions] And your next question comes from Joe Mondillo with Sidoti & Company. Your line is now open.

Hi, guys, good morning.

Hi, Joe.

I have a few questions on power systems. First off, looking at the fourth quarter, the revenue - I know you addressed aftermarket parts not being as strong and I imagine that margin is going to be lower - easily lower year-over-year - but the revenue on the fourth quarter of 2015 was pretty inflated. Are you expecting that to be a very tough comp on the revenue side of things? And then on the last call I believe you said the back half of the year of this year, margin was going to be similar to the first half of this year. So if that's still sort of the case, that would put fourth quarter margins at maybe potentially single digit area. So I'm just wondering your thoughts on that.

Yeah you got it right, Joe. The system in what we've talked about previously on a year-over-year basis in power systems we expect sales to be down in the fourth quarter and we also expect operating income in margins given the outlook for the aftermarket parts of the business to be down. We could be single digit. It all depends. We don't know completely what will come in on aftermarkets. We have a pretty good read on what's going to happen on the new engine shipments side and the percentage of completion revenues, but from an aftermarket standpoint there are still some uncertainty there.

Okay.

But clearly, it's going to be lower than it was in the fourth quarter of last year.

Okay and then sort of on the revenue side comparing it to - you've been trending around a little over $50 million the last three quarters on the revenue side of things. The last two years you've seen a big pop in revenue in the fourth quarter. Are we still anticipating sort of a sequential pop and maybe just not as strong as a year ago or could it be sort of similar to what you've seen in the first three quarters of this year?

Yes, I think it's going to be more comparable to what we saw in the third quarter. I don't anticipate given the pressures we're seeing in the market that it's going to be up. I think we talked about this, I know we did earlier in the year, or maybe after the first quarter that we anticipated certain amount of revenue at zero margin that would affect the top line in power systems this year that we had a contract. It's an old contract that we expected to complete and it's our last significant program on a completed contract basis with revenues of roughly $10 million that has been deferred into 2017. So, that will obviously affect the top line. It won't have any impact on the bottom line since it was at zero margin.

All right, great. And then looking at 2017, a few things. The OPC contract that you just announced. I'm wondering if you could help us sort of understand maybe the magnitude of benefits that that program is going to benefit you on an annual basis in terms of revenue and is this going to be similar-type margin that you received in terms of the overall segment margins? Any help there would be great.

Well, as I mentioned in my remarks, Joe, the first ship is not scheduled to being served until 2021. So, we don't anticipate a lot next year because it will [indiscernible] some of the long lead time procurement items on a percent-completion basis. We wouldn't really build a whole lot in for next year, at least in terms of what we know now down the road. Obviously it's two good-sized engines per ship and it will crank up in earnest in '18 and '19 and it will be at I would say normal new engine margins that we see as you know is that there's a heavy mix effect in Fairbanks based on aftermarket parts and service relative to new engines. That's why it's always difficult and while it's fairly easy to look forward for a new engines, it's actually not easy to look forward in the aftermarket because we get stuff rights, we get emergency orders that we have to get out and those typically carry the better margin and we can't see those coming in many cases. These are these are predominantly for engines that are fully in service. Right? And a lot of it requires fabrication. That's why we have a little bit of trouble pinning exactly what the aftermarket looks like and the size of many of these aftermarket orders - even relative to the size of sales of Fairbanks in any given quarter can move it quite a bit. If the team is able to get out literally in the last couple of weeks of the quarter, is able to get out a lot of aftermarket orders that we haven't anticipated, it will make a big difference. We had that benefit last year fourth quarter and we set a record in Q2 this year of aftermarket part sales. Both the year-over-year and the sequential comps are tough on Fairbanks Morse. I think if you look at kind of our level on the aftermarket side in Q3, that's probably a better guess that we're going to do in Q4. That's how we think about it, anyway.

Okay. And then a couple of other questions actually. In terms of 2017 outlook, I know you have the EDF contract and I think that's going to weigh on your margins just given how that sort of program has sort of worked out.

Unless currency moves in in our favor. That's the other thing that can happen. If for whatever reason the euro strengthened substantially relative to the dollar back towards where we were when we cut the deal, it would jump into positive territory because as you know we have to account for this, that the bookings we're taking now assume the currency stays the same through the end of the entire program - not just for this quarter, but the end of the entire program.

Right. Actually that's a good point. Thanks. Just say for hypothetical, if currency stays flat from here, upside...

Then it's a lot of zero margin revenue.

Right. And then you have this $10 million deferred. We're probably looking at down margin, maybe potentially near single digits next year temporarily and then maybe 2018 looks a lot better. Is that a good way of looking at the segments in 2017?

On the margin front, I think that's accurate. We should have a pretty darn good sales year next year for Fairbanks and I would actually anticipate the gross margin dollars. The other stuff that we're working on obviously carry - the engines that got deferred in the next year are done. They're just waiting to shift, so they're not going to drive any cost. The activity that's going on in the shop other than the EDF obviously still carries a margin. So it's going higher revenue that comes with no margin.

You're correct, that's going to drive margins because there will be a significant amount of revenue associated with the contract that is deferred to next year, the $10 million that we referenced earlier plus EDF.

Okay, great.

But unless currency changes, the combination of those two will have a significant impact on margins next year.

Great. Okay. Exactly what I was looking for. And then lastly, could you update us on the OP 2.0, where we are in that exactly in terms of sales and where we are in terms of innovation and everything regarding that?

Yes. Well, it's very exciting to me. It's probably still a little too far out to get too excited, but we are entering the final test phase between now and the end of the year, the final - what I call R&D test phase of the OP 2 - and by the end of the year we will have or very early next year we will have established all of the operating design parameters that we were looking to figure out. Again, the performance of the engine has been very, very good. It's been frankly at least meeting, if not exceeding our expectations in terms of the technical performance of the engines. So we're quite excited about it and then beginning next year we will begin building essentially the first engine that we want to get into service. It will still be a 'developmental engine' because we will need a launch partner that is prepared to put it in the field and run it. We have a few customers that are interested in being our launch partner and we're still working with them. But we won't be in a position to actually probably sell. We're hoping that late in '17 when we have an engine that has been in the field for a while, is really performing, we can actually point to it and show the actual results of when we'll start to be able to hopefully to books and sales and then based on that we'll keep you informed. We're pretty pleased with where we are in the program.

Okay, great. Thanks a lot. Appreciate it. I'll hop back in queue.

Yes.

I want to add one comment to Jeff's question earlier about sealing because I think we probably ought to give you a little color on heavy duty trucking and what we're seeing there. There's no surprise that on both the OE side; trailers and tractors, that we've seen decline this year. So the impact that we saw in Q3 was partly related to that, it's in the part of our business that has more exposure to OE which is more on the brake product's side, than it is our wheel and ceiling products. So we saw some effect there, we also though had a reduction in the top line in STEMCO as a result of some planned exits that we decided when we were talking earlier associated with the Air Springs business where we made some decisions to redirect our volume to the aftermarket from the OE business and so there is a - that creates a kind of a loss that was planned, that didn't really affect our profitability as much as it did the top line. And then finally, we've had some supply chain disruptions that are leading to a temporary loss of sales that we'll catch up on later in the year. So just a little bit more color on STEMCO, the business, the team is still performing quite well.

At this time there are no further questions. Pardon me, we do have a question from the line of Joe Mondillo of Sidoti & Company. Your line is now open.

I just had a couple of follow-ups if you don't mind. First off all, in terms of the engineered products segment, if you were to take out sort of excluding - sort of the planned site exits on a revenue basis what kind of revenue year-over-year decline would that be?

Yes, it's a really tough call Joe because when we - lot of insights - we're actually were in Western Canada; and then two phenomenon happened. One is, we sold under our agreement rather than shutting down, we actually sold one of the larger of those sites to - essentially the management team up there and entered into a parched contract to continue selling CPI parts through them. And the second is, we did keep some sites opened in Western Canada, the ones that were profitable because we were able to shift some of the product - some of the customer volume that we were - that we had in the sites, we only shifted to the sites that we kept open. So we haven't been kind of quoting anything because quite frankly, it's just very, very hard for us to determine how much of that business we actually retained versus not. Certainly we did move some volume by sites that were exited but we didn't lose - if you follow, we didn't lose 100% of the volume from a 100% of the sites that we exited. So if you're asking about the general market - we feel in CPI, I certainly think that Q3 was about on-par - if you've kind of think about seasonally with where we were in Q2 and this year was definitely weaker than last year in terms of just market demand. But the good news is - in some geographies we saw some weakness, Milt mentioned in Europe in this quarter. But it feels to me like things have stabilized and we have a decent backlog at some of our sites. So I think we're - I think we've got the worst of it behind us and the question then just becomes, what's the refining then in petrochemical and gas pass volume going forward. I know that's a qualitative answer to your question and you probably wanted some numbers but we really just can't -

No, that actually gives enough color that I can sort of understand what you're sort of talking about. I appreciate that. It sounds like things are stabilizing. In terms of GGB, its - if I read - I think in the release and in your commentary, it sounds like that business has been sort of stable as well. So overall, the engineered product segment - can we call that somewhat stabilizing at this point in the near-term at least?

Yes. I mean from a top line it's been fairly stable. We're down a little bit in Q3 because it continued weakness year-over-year but we're performing much better at a much higher level. I think you picked up on the comments that we've made and just by looking at the segment margins. So there is significant improvement in our performance. But it's not coming as a result of volume, we're still feeling challenged from a volume side. In GGB as well as CPI as Steve covered.

And then last, actually - in terms of the restructuring, the $20 million; how much of the benefit have did you really see in the third quarter and I imagine most of the rest of the benefit incrementally will be in - I guess the fourth quarter and the first quarter considering that it will be done by year end but I guess you'll see a little bit of incremental on the first quarter?

Let me, and Milt can add to this Joe. As we said in the last call, most of the actions that we implemented were actually very, very late in Q2. So we went into Q3 with a very high percentage of the actions done and then obviously we had the European fall-through and so forth. So I think we got pretty - I think we're pretty darn close to the full run rate that's already reflected in Q3 numbers.

Joe, we've provided a little bit of additional information in our prepared remarks around pro forma SG&A and while not all of the restructuring shows up in SG&A, it's enough that information gives you some flavor sequentially. For reduction in costs compared to the second quarter. And you can see by that that we've - it just backs up what Steve has just said that we're really getting that run rate pretty much shown up fully in the third quarter.

Okay. And then just lastly in terms of regarding GST, while the year-over-year comparisons have been really tough and I mentioned that end-markets are still a little uncertain, the absolute number - the absolute value of your revenue over the last three quarters have been fairly, where usually it tends to peak in the second quarter; and it's down in the third quarter. And then also same type trend with the margins, they've been fairly stable this year. So just wondering if that's any indication that maybe things are stabilizing at GST?

We don't feel like things are getting worse and as I mentioned earlier - but we continue to have these challenged markets with metals and mining and refining and petrochemical. We don't feel - like it's getting worse - I think your observation backs up the data that you're looking at, it backs up what we're seeing.

Okay. All right, thanks a lot. I appreciate it.

And there are no further questions. I turn the conference back to Mr. O'Neal for closing remarks.

Thank you, Shawn and thank you all for joining us this morning. If you had any additional questions please give me a call at 704-731-1527. Have a good day.

This concludes today's conference. You may now disconnect.